Thursday, September 01, 2005

Who Are The Real Looters?

Mr. Robert Person of Madison, Wisconsin thinks the real looters in every disaster are the gas and oil companies. He writes in a letter to the editor of the Capital Times (for some reason Yahoo News highlighted this):
In the immediate aftermath of the devastation, gasoline pump prices have gone up a huge amount. Now, it takes a month or more for oil to be refined and gasoline to be produced and delivered. Yet current pre-disaster stocks of gasoline are being sold at inflated prices. Who is the looter in this case? The oil companies? The marketers? The wholesalers? Are security forces out to nab them?
I've already explained why a gas station owner must raise prices as soon as his supply is interrupted and most of what I said applies here. Mr. Person seems to mistakenly assume that a single entity controls oil through the entire delivery and refining process. But oil and gasoline flow through networks of wholesalers and distributers just like other products. I'm not certain of this, but I wouldn't be surprised if most big oil companies like Exxon and BP have distribution franchises just like PepsiCo and Coca-Cola. They certainly have station franchises which take ownership of the gas delivered to them. Each entity in the supply line must respond to supply and pricing changes just like the service station owner at the retail end of the line. If you don't understand why go read my earlier post.

The second thing Mr. Person doesn't understand is that pricing must reflect current conditions as well as uncertainly about when those conditions will change. The gas flowing through retail pumps now may have been purchased before Katrina struck (though I seriously doubt the refining and delivery process takes a month), but prices started to rise before the hurricane struck to reflect the risk of a supply interruption. The interruption then became certain and prices rose further. They will remain high because no one knows exactly when or to what degree supply will be restored or what future demand will be. If you know in advance the price of gasoline for next month please tell me and we'll make a killing trading gasoline futures. (Right now the NYMEX says wholesale prices will be $2.40 per gallon in October--about $1 more than last October.)

Think about it this way: You're an English colonist at Jamestown. It's 1609 and your community is not yet self-sufficient. John Ratliff, the president of the colony is dead. You need regular shipments of supplies from England or you'll starve. You expected a ship to arrive in early September, but now it's mid-October, and there's no sign of the ship. It could have been delayed crossing the Atlantic. But it might have been sunk by the Spanish or captured by pirates. A difficult winter lies ahead. The summer harvest was poor--especially since John Rolfe wasted his time growing tobacco instead of corn--and without additional supplies many will starve. Do you A) Start conserving food now in case the ship never shows up; or B) Reason that there wasn't a shortage in August when you harvested the corn in the storehouse so you'll wait until the ship definitely doesn't show up to begin conserving? Congratulations if you chose option A. I'm sure Mr. Person would as well in those circumstances. The reason you chose option A is that the food you have now became more scarce/valuable/costly because of current conditions of supply, regardless of the conditions when you first obtained it.

Changing prices are the fastest, most accurate signal of current supply conditions at each level of distribution--so long as we let them work. And they work in reverse as well: When supply improves prices sometimes drop so quickly that sellers are forced to sell goods for less than they paid for them! That's one of the reasons companies are willing to invest billions of dollars streamlining supply chains and collecting oceans of data about who buys what, when, and for how much--because the more inventory stuck in their warehouses the more vulnerable they are to unfavorable supply and demand changes. Which is why accusing oil companies of secret conspiracies to shrink their inventories and artificially boost prices is so ludicrous--every major company on the planet has been trying to shrink their inventories for at least the past two decades!

Maybe next time I'll explain why people like Mr. Person and the politicians who pander to them are themselves the real looters!

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